Assignment X3.2

[almost_there]

Who on earth would take a tax-free lump sum and invest it in an annuity with worse rate than their existing annuity... wouldn't people be better off not bothering to take the lump sum and just take it all as an annuity in the first place?

It seems terribly irresponsible to advise anything else! Are we meant to spend 2 hours constructing a presentation saying "Don't do this!" ??!??

Is this question really thought through by Acted?

 

[David Wilmot]

Is this question really thought through by Acted?

In short, yes.

I think you’ve missed a subtle point: those who pay tax will receive a higher after-tax income from the purchased life annuity than the normal pension annuity. This is why, for such individuals, they would be better off taking the tax-free lump sum and investing it in a purchased life annuity - when compared to not taking such a lump sum and using the full fund to purchase a pension annuity.

Perhaps, in hindsight, you might have worded your post differently?

 

[almost_there]

Thanks. So the purchased annuity rate is 10-20% less than the compulsory annuity but they pay less tax on it... it's unclear without doing a lot of extra calculations what the offset is & who'd benefit in what circumstances.

 

[almost_there]

I've created a spreadsheet to investigate what pension pot size, what lump sum % taken results in being better off ... the picture is far from clear, even for a taxpayer.

e.g. pension pot 160,000 aged 65. No lump sum taken. Compulsory is 160,000 * 7.210% = £11,536 which makes him a taxpayer (>£10,500) marginal rate 20% so net is £11,329.

Alternatively take a 25% lump sum tax free and put in a purchased life annuity you get compulsory = 8,652 and purchased life annuity = 2,538 (no taxes here) gives total £11,190

Conclusion: he's better off taking the compulsory and paying the tax, than being a non-taxpayer.

However if I change the lump sum % taken to 10% rather than 25% then I get him better off taking the lump sum purchased life annuity route by £69.

I'd say you'd need to get a macro to run through the various lump sum % and pension pot size possibilities to find the turning points where you'd be better off taking purchased life annuity.

With two critical variables at play it seems like a lot of calcs needed before properly answering this question?

I don't think the acted calc solutions are appropriate to state an individual is a non-taxpayer, basic taxpayer or higher rate taxpayer since the choices you can make don't necessarily keep you in that same tax category.

 

[David Wilmot]

The key to passing CA3 is keeping the communication as simple as possible, whilst still answering the question posed.
In this case, we are asked to explain what PLAs are and how an individual might decide whether to buy one when they retire. Our sample solution includes some examples that illustrate how a PLA might be used in certain specific example circumstances. (Including examples after a generic explanation is good practice in CA3.) It does not state that these examples are indicative of all possible circumstances.
Indeed the narrative in the solution goes to some pains to emphasise this point... "I strongly suggest that you seek advice from an independent financial adviser prior to retirement. Consideration of your potential tax status will be part of that process." So no attempt is being made (or should be made) to give comprehensive financial advice.
So, the solution meets the objectives in explaining what a PLA is (both generically and by means of illustrative examples), how it could be used in specific circumstances, and how they should decide on whether one is right for them (by consulting an adviser).

 

[almost_there]

OK thanks. I am shocked that for this one we could get away with saying consult a financial adviser as that seems a cop-out. That doesn't look like adequately answering the question to me of "how they should decide on whether one is right for them". It's just offloading it to the financial adviser & besides it would be up to the financial adviser to know about these options already.

Furthermore isn't it misleading to provide so many facts and figures and expect us to ignore them all and say "consult a financial adviser". I reckon most people would spend precious time at least trying to figure out if the question's data suggests an obvious message to be communicated.

I think people would end up disappointed with the presentation in the solution since it just gives one example, which may not be relevant or correct to them. It could seriously mislead if they think the arguments made apply to pension pots regardless of size & lump sum taken.

I thought the test in CA3 was that to communicate a clear message. Unfortunately to get to it you sometimes have to do some digging or extra calcs, ignoring the distractions and irrelevant information in the question. For me, this question does not have that clear message waiting to be communicated & requires way too much analysis and calcs.

 

[bystander]

Almost_there, stand back for a moment and think about what happens in real life. We have vast amounts of data etc at our disposal, or supplied to us by a customer, and calculations we can do from this but it's not always appropriate to use everything. The second point, is I take it in this question you are told you are an actuary (my apologies I don't have access to this years assignments so I'm working on a premise of other CA3 questions I have come across). Actuaries unless they have the right authorisation cannot give explicit advice, but are allowed to offer generic guidance. Hence, discussing a concept and following up with just one illustrative example, is appropriate and offering a pointer to someone who can give tailored advice, do a full fact find etc in accordance with regulation. The solution you see presented is of course also only an example. It cannot be definitive just because of the nature of communication. You may equally want to offer two examples, as you see fit. Alas, on exam day, you will be faced with a question over which you have no control. But, from practise and understanding feedback, you can develop the skill needed to pass. I wish you well in your learning curve and for exam day.

 

[almost_there]

bystander, you state that providing one example is appropriate. I don't think it is. People will project from that example for their own circumstances. We're encouraged by acted tutors to dumb everything down. So I could have done a presentation saying generally don't do this, generally not a great idea as the rates are poorer lately, just take the compulsory and given one example in support of that. Then acted would have bashed me for not considering other scenarios etc. but the truth is there are too many scenarios here for an 8-10 minute presentation, so whatever you end up giving is incomplete & misleading to some of your audience.

 

[bystander]

My only other recommendation to you is not look at solutions, or any assignment attempt feedback picking out individual elements, but also look at the piece as a whole. It has to address the question and have the right tone and feel and also be within any regulatory guidance although strictly Ca3 isn't testing your knowledge of that nor are you expected to have read it. That's why, in for example, code of business rules from the regulator, there are caveats. For example, in advertising it gives one scenario or maybe two but goes on to say this is illustrative only and may not fit your case,therefore please consult an independent financial adviser. Don't take these words verbatim, I am paraphrasing. Your suggestion of giving explicit advise could get you into professional trouble in reality. I really do sense your frustration and do so want to help. Ithink Acted mentioned earlier in their suggested solution that they included appropriate caveats that the one example isn't indicative and it's important to caveat. I think the question here was to say why it might be appropriate to do part pla part 'regular' annuity, so saying don't do it isn't the way to go. Exam questions in ca3 aren't set with traps like that. There really is no unique solution that will pass and remember as in all exams you don't have to score 100% to pass. . It's getting the balance right. Good luck.